A financial mirage

Kim Dong-ho
The author is an editorial writer of the JoongAng Ilbo.

The Financial Times recently ran a story from Seoul entitled “Scandals rock South Korea’s booming hedge fund industry.” It was embarrassing to read such an exposure of the shadows of our society. Scandals came out of the private equity and hedge fund industry starting last year, but I did not pay much attention to any of it. As usual, slack supervision, scams and dubious marketing by banks brought about catastrophe for some gullible investors. I thought prosecutors would get to the bottom of the cases soon. And some individuals would inevitably have to swallow losses for misjudgments. That’s the name of the game in investments.

The scandals upended the country’s long-held aspiration to become a financial hub in Asia. Since the government of President Kim Dae-jung in the early 2000s, Seoul has tried to remold the country into a logistics and financial hub for Northeast Asia. President Roh Tae-woo laid the foundation by building a new air gateway in Incheon. With a world-class international airport and an economy performing amongst the world’s top 10, Korea indeed was qualified. But that dream has been dashed as the credibility of the financial industry hit rock bottom under the current Moon Jae-in administration.

Credibility is of utmost importance in finance. Even a savings of 1 cent cannot be possible if there is no trust in financial institutions. Fraud cases involving Lime Asset Management and Optimus Asset Management could not have panned out in more reliable financial hubs like New York, London, Hong Kong and Singapore. Losses can occur in those places if the economy tanks or corporate performances disappoint, but not from outright deception of customers.

Even while the private equity funds recruited investors, misappropriated their money or lost it in poor investments, the financial authorities remained clueless. The government and financial watchdogs were helpless while billions of dollars were being wasted and fraudulent financial products were sold by unqualified equity funds. Our financial system had a huge hole.

The country should have learned from the humiliating financial crisis of 1997. The international bailout owed much to the impotence of the government. After joining the Organization for Economic Cooperation and Development (OECD) in 1996, the government rapidly lifted foreign currency-related regulations. But it was lax in supervision. A plethora of companies rushed to borrow foreign money. The snowball of short-term foreign debt triggered the financial crisis. The government naïvely believed that it could join the ranks of developed economies once it joined the OECD.

The latest scandals with private equity funds are no different. The government has been promoting these funds since 2015. The number of PEFs in Korea mushroomed to 3,324 in 2019 from 615 in 2015. Their assets ballooned to a whopping 400 trillion won ($363.4 billion). Unlike publicly offered funds, private funds are restricted to 49 investors and are not subject to disclosure. As a result, PEF management stayed in the dark.

Scammers flocked to the industry. They recruited individual investors by claiming that their money would go into safe assets like government bonds. In fact they were invested in high-risk assets. Customers’ money was also used to lobby politicians and government officials. The government’s role of safeguarding people’s lives and assets did not function. Those who were burned were mostly retirees in their 60s and 70s. Their life savings went down the drain as they fell easy prey to schemers.

The government at least should have done its cleaning work well. Investigating private funds for three years and punishing the swindlers cannot be enough. It must strengthen financial education for the general public. Most people do not know how equity funds work. The foundations must be set from the start if the country still wants to hold onto the dream of becoming a financial hub for the region.